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Chapter 21 Perfect

Chapter 21 Perfect Competition The basic economic problem is scarcity. Human wants are unlimited. Resources are limited. The basic goal in dealing with the problem of scarcity is to produce as much consumer satisfaction as possible with the limited resources available. To achieve this goal, society must use its limited resources as efficiently as possible. How efficiently a particular firm uses its resources will depend on the market structure that the firm operates in. Economists have identified four different market structures, ranging from perfect competition at one extreme to monopoly at the other extreme. The four different market structures will be examined in this chapter and the next two chapters. The four different market structures are characterized by different levels of market power. Market power – the ability of a seller or a buyer to affect market price. The market structure that a firm operates in will affect the firm’s market power. The degree of market power that a firm has will affect the output and pricing decisions that the firm makes as it attempts to maximize profits. The degree of market power that a firm has will also affect the firm’s economic efficiency (or inefficiency). The ideal (most efficient) market structure is perfect competition. Perfect competition – many sellers of identical products. Perfect competition is the ideal market structure. For reasons detailed later in this chapter, a perfect competitor will generally produce the economically efficient quantity of output. The key characteristic of perfect competition is a lack of market power. Each perfect competitor has no ability to affect market price. A perfect competitor is a “price taker”. A perfect competitor cannot make the market price go up or down, nor can it stop the market price from going up or down. A perfect competitor must simply “take” the market price as it is. The two primary reasons that a perfect competitor has no market power are: 1. There are many sellers in a perfectly competitive market. Each seller is relatively small compared to the total market. No single seller produces a significant share of the total market output. Thus, if a perfect competitor increases or decreases its output, the market price will be unaffected. Example 1: In a typical year, about 2 billion bushels of wheat are produced in the U.S. A fivehundred acre wheat farm (about the average size) would produce around 20,000 bushels, or .001% of the nation’s total crop. 2. All firms in a perfectly competitive market sell an identical product. Thus, no buyer would be willing to pay more for one firm’s product than for another firm’s product. All firms will sell at the same price, the market price. Example 2: When was the last time you saw a television commercial featuring a farmer? Imagine Farmer Vilsack boasting, “Buy my corn. It’s the best corn. It costs a little more, but it’s worth it.” Another characteristic of perfect competition is freedom of entry and exit. New firms can easily enter a perfectly competitive market and existing firms can easily leave a perfectly competitive market. This will be important when we look at perfect competition in the long run later in the chapter. FOR REVIEW ONLY - NOT FOR DISTRIBUTION Example 3: When corn prices in the U.S. increased by almost 75% from 2010 to 2012, the number of acres planted in corn increased by over 9 million acres. When corn prices decreased by about 30% from 2012 to 2014, corn acreage decreased by over 5 million acres. 21 - 1 Perfect Competition

The Demand Curve for a Perfect Competitor A perfect competitor has no market power. Since a perfect competitor is unable to affect the market price for its product, a perfect competitor will face a demand curve for its product that is horizontal (perfectly elastic) at the market price. Example 4: Percomp Company is a perfect competitor. Percomp produces about .001% of the total production in its market. The product that Percomp produces has a market price of $10. If Percomp increases or decreases the quantity that it produces, this will not have a significant effect on the supply in the market. The market price will remain at $10. Thus, the demand curve for Percomp is horizontal at the market price of $10, as illustrated by the demand schedule and the demand curve below: $13 - 12 - 11 - 10 - Price 9- 8- 7- 6- 5- Percomp Company Demand Schedule Price Quantity Demanded $10 1 10 2 10 3 10 4 10 5 10 6 10 7 10 8 10 9 Z 0 0 1 2 3 4 5 6 7 8 9 Quantity D = P Since a perfect competitor has no market power, a perfect competitor is a price taker. It cannot “make” the market price change, but must simply “take” the market price as it is. For each of the three other market structures that we will examine in chapters 22 and 23, firms have at least some market power. Thus, they are able to affect the market price for their product by increasing or decreasing their production. But a perfect competitor cannot affect the market price for its product. FOR REVIEW ONLY - NOT FOR DISTRIBUTION Perfect Competition 21 - 2